Antifraud Provisions

Both provisions ban deceptive devices and conduct that operates as a fraud. The universal provision bans misstatements and misleading omissions directly; the advisory provision bans them only in the solicitation of clients, as a separate clause. Spotting which prong or clause a scenario fits is most of this lesson's exam value.

What Does the Universal Antifraud Provision Prohibit?

The universal antifraud provision makes it unlawful for any person, in connection with the offer, sale, or purchase of any security, directly or indirectly, to:

1. Employ any device, scheme, or artifice to defraud
2. Make any untrue statement of a material fact or omit a material fact necessary to make statements not misleading (in light of the circumstances under which they are made)
3. Engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person

This provision is modeled on the federal antifraud rule under the Securities Exchange Act of 1934, which uses nearly identical language.

Who and What Does It Cover?

The universal antifraud provision has the broadest possible reach in the Act:

• Applies to offers, sales, and purchases; it protects both buyers and sellers
• Covers every person: registered or unregistered, broker-dealer or issuer, individual or entity
• No registration is required for it to apply; even an unregistered person acting unlawfully is subject to it

Exam Tip: Gotchas

The universal antifraud provision has no exemptions. The exam frequently tests whether an exemption from registration also exempts a person from fraud liability. It does not. Even an agent selling an exempt government bond or completing an exempt transaction (like a private placement) is fully subject to it.

The Three Prongs

Understanding the three prongs helps you spot violations on the exam:

Key distinction: Prong (3) does not require the Administrator to prove intent to defraud. If conduct operates as fraud (meaning it has the effect of defrauding someone), it violates the provision regardless of whether the person intended to cause harm.

Sanctions for Violations

Violations of the antifraud provisions can trigger multiple types of enforcement:

• Administrative proceedings: Denial, suspension, or revocation of registration
• Cease and desist order: Issued by the Administrator, with or without a prior hearing
• Judicial injunction: The Administrator brings an action in court; the court grants the injunction, and may also order rescission, restitution, or disgorgement
• Criminal prosecution under state law: Up to $5,000 fine, 3 years imprisonment, or both for willful violations
• Civil liability: A private right of action for the buyer (or, for advisory violations, the client), subject to conditions and time limits covered in full in the Civil, Criminal, and Judicial Remedies unit

Exam Tip: Gotchas

Criminal penalties require willful violations, but administrative and civil actions do not always require proof of intent. The Administrator can take action based on conduct that operates as fraud under prong (3), even if the person did not deliberately set out to defraud anyone.

What Does the Advisory Antifraud Provision Add?

The advisory antifraud provision applies the same antifraud logic to anyone who receives compensation for advising others on securities, whether or not they are registered as an investment adviser.

It makes it unlawful for such a person to:

1. Employ any device, scheme, or artifice to defraud the client
2. Engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon the client
3. Acting as principal, knowingly sell to or buy from a client (or, acting as broker for someone else, knowingly effect a trade for the client's account) without disclosing in writing before completion of the transaction the capacity in which the person is acting and obtaining the client's consent
4. Engage in dishonest or unethical practices as the Administrator may define by rule

A separate clause bans, in the solicitation of advisory clients, any untrue statement of a material fact or a misleading omission. The four numbered prohibitions above govern the advice itself; the solicitation clause governs how a client is brought in to begin with.

Exam Tip: Gotchas

The written disclosure and consent for principal trades apply before completion of each transaction, not once at account opening. That rule does not apply to a transaction with a broker-dealer's customer if the broker-dealer is not acting as an investment adviser in that transaction. The per-transaction consent rule and its full exceptions are covered in the Prohibited Activities and Conflicts of Interest unit's principal-transactions lesson; here, the point to remember is that the advisory antifraud provision is where that requirement comes from.

The fraud prongs (device to defraud, fraud or deceit, and the solicitation misstatement ban) have no exemptions, just like the universal antifraud provision: a person who receives consideration for advising on securities is subject to them whether or not they are excluded from, or exempt from, investment adviser registration. The Administrator can, by rule or order, grant narrow exemptions from the principal-transaction disclosure requirement itself, unlike the fraud prongs.

What Should You Check on Exam Day?

• The universal antifraud provision reaches every offer, sale, and purchase, of every security, by any person, with no exemptions; an exemption from registration is never an exemption from fraud liability.
• Its three prongs cover deceptive devices, misstatements or misleading omissions, and conduct that operates as a fraud; only the third prong is explicitly effect-based rather than intent-based.
• The advisory antifraud provision has two fraud prongs of its own, a separate principal-transaction disclosure-and-consent requirement, a dishonest-or-unethical-practices prong, and a solicitation-specific ban on misstatements; the fraud prongs have no exemptions, but the Administrator can exempt the principal-transaction requirement by rule.
• Criminal penalties require a willful violation and cap out at a $5,000 fine, three years imprisonment, or both; administrative and civil remedies do not require the same proof of intent.